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A Court Is A Poor Place To Air Dirty Linen
Law360, New York (April 07, 2014, 6:31 PM ET) -- Dramatic charges of wrongdoing in the international
high-end art market were lobbed about in Mosionzhink v. Chowaiki et al., Index No. 650434/2009 (Sup.
Ct. N.Y. Co.). Justice Shirley Werner Kornreich rendered a decision in July 2013 on dueling motions to
dismiss and for summary judgment, and the parties thereafter settled.
Although the settlement agreement is confidential, four years of pleadings are publicly available on the
electronic docket. Oscar Wilde and others have said that there is no such thing as bad publicity, but it is
unlikely that these parties would agree. Lesson to counsel: litigation in a public forum may be “a loser”
for the interests of each and every party. When mud gets slung about, everyone gets dirty.
The Facts
According to her amended complaint, Luba Mosionzhnik is an “internationally acclaimed and renowned
expert and dealer specializing in 19th and 20th century impressionist, expressionist and modern art,”
and defendant Ezra Chowaiki “has worked as an unsuccessful screenwriter and then as an ice cream
salesman for his father-in-law.”
Notwithstanding these apparent differences, in 2004, Mosionzhnik and Chowaiki decided to establish an
art gallery to deal in modern art by well-known artists in the collections of private collectors and dealers.
Chowaiki approached an individual described as a director of various Fortune 500 companies to be a
passive investor, and the three of them moved forward.
On behalf of all three principals, counsel organized Chowaiki Mosionzhnik Gallery Ltd. (later renamed
Chowaiki & Co. Fine Art Ltd.) (“gallery”), and drafted a shareholders’ agreement and employment
agreements for Mosionzhnik and Chowaiki. Under the shareholders’ agreement, the passive investor
owned 50 percent of the shares, Mosionzhnik and Chowaiki each owned 25 percent, and all three were
directors.
Mosionzhnik and Chowaiki had virtually identical employment agreements. These agreements were for
an indefinite term, provided $120,000 in annual salaries, and designated Chowaiki as president and
gallery director and Mosionzhnik as vice-president, secretary and gallery director.
The shareholders’ agreement expressly permitted self-dealing. Mosionzhnik and Chowaiki would be
permitted to “continue to deal with and in fine art, including private transactions and the creation of a
hedge fund [provided that he/she would use] best efforts to enable the gallery to share in the fees
[each] may earn ... after the opening of the gallery.”
From inception, Chowaiki informed Mosionzhnik that he was engaged in discussions with a “foreign
heiress” who was in estate litigation to establish ownership of extremely valuable paintings, with the
goal of permitting the gallery to acquire the art if the heiress were successful. Counsel who prepared the
other corporate documents formed “Zelco” to fund the estate litigation in exchange for the right to
acquire the subject paintings at agreed prices (“Project Gamma”).
The complaint alleges that although Zelco was to be owned equally by Mosionzhnik and Chowaiki,
unbeknown to Mosionzhnik, Chowaiki caused himself to be named Zelco’s sole shareholder and
director. The gallery performed all of Zelco’s obligations, including spending more than $3.4 million to
fund the estate litigation. The gallery’s accounting records reported Project Gamma as a substantial
asset.
Upon formation of the gallery, Mosionzhnik went to Russia to generate business for the gallery.
Mosionzhnik and a Russian citizen opened a Moscow gallery in 2007. Mosionzhnik alleged that an
informal agreement existed between herself, Chowaiki and the Russian that the gallery would receive 50
percent of the net profits from the Moscow gallery business.
In 2008, Chowaiki and the passive investor confronted Mosionzhnik, claiming that she had been stealing
from the gallery and demanded that she resign. She refused. After negotiations failed, the gallery
terminated her employment for cause. In that connection, pursuant to the shareholders’ agreement, the
gallery retained an accounting firm that valued her shares at $170,000.[1]
Because the gallery claimed that Mosionzhnik owed the gallery much more, it refused to pay her for her
shares. Mosionzhnik, for her part, claimed that Chowaiki improperly received an additional $6,000
monthly net income and withdrew gallery funds to pay personal expenses, including his personal
mortgage. In addition, at the commencement of the case, each party was in possession of artworks
he/she acknowledged were owned by the other.
The Litigation
The Complaint. Believing that she was owed money under both the shareholders’ and employment
agreements, Mosionzhnik filed an extremely colorful 12-count complaint.[2] She alleged oppressive
conduct toward a minority shareholder, a scheme in violation of state and federal RICO laws,
defamation and defamation per se, fraud and fraudulent inducement (including an allegation that
defendants fraudulently misrepresented that the gallery would have to file for bankruptcy if
Mosionzhnik did not approach her rich Russian cousin with a fabricated story to induce the cousin to
buy expensive paintings from the gallery), and numerous other claims. She sought monetary damages,
dissolution and/or purchase of her shares, an accounting, and demanded an injunction.
The Answer and Counterclaims. These are every bit as colorful as the complaint, which the answer
claims is “of a piece with the numerous frauds which prompted her termination for cause ... nothing
more than a mask for looting the gallery, ...” All defendants asserted affirmative defenses.
The gallery asserted counterclaims in excess of $20 million in actual damages plus punitive damages for
breach of contract, fraud, breach of fiduciary duty, conversion and unjust enrichment arising from
Mosionzhnik's alleged:
(a) conversion of funds through an unauthorized Swiss bank account;
(b) false representations that the Pushkin State Museum in Moscow would conduct an exhibition of
abstract expressionist art for the benefit of the gallery, which caused the gallery to send paintings to
Moscow and incur substantial costs and “public embarrassment and a devastating blow to its
reputation;”
(c) wrongful use of art consigned by private investors to the gallery as collateral for unauthorized
personal sales of art;
(d) misrepresenting herself as gallery chief executive, forging Chowaiki's signature and falsifying bank
documents;
(e) improper art purchases and sales and misrepresentations about the value of artwork created by her
boyfriend artist; and
(f) fraudulent use of the gallery’s credit card and improper gifts of gallery assets to her parents.
The Decision. Four years after litigation began, and after an extraordinary number of motions and court
conferences and substantial discovery in the United States and abroad pursuant to commissions, both
sides moved to dismiss and/or for partial summary judgment.[3]
Kornreich dealt with and simplified a morass of competing claims and dismissed the bulk of them,
substantially decreasing the amount of potential damages and leaving defamation, tortious interference
and breach of contract for trial.
However, she directed the parties to mediation given the relatively small amount at stake and the
significant trial costs. As she noted, allegations “made in a public trial, often have the potential for
significant reputational harm for all participants, regardless of who obtains a favorable verdict.”
The Fraud Issues. Kornreich noted that Mosionzhnik “admitted to committing the most egregious of the
alleged improper acts. She secretly opened a Swiss bank account which she used to divert approximately
$500,000 [in kickbacks] related to the gallery’s art sales and used over $13 million of art consigned by
the gallery’s clients as collateral for loans without the clients’ knowledge or consent.” (footnotes
omitted)
She rejected Mosionzhnik’s “defenses” that her admitted kickbacks, while not ethical, “happens because
it’s the art world,” and that Chowaiki told her it was accepted practice in the industry to use client art as
collateral and that Chowaiki also improperly did the same thing.
The court held that Mosionzhnik’s admissions were sufficient to grant the gallery summary judgment for
breach of fiduciary duty. However, Mosionzhnik’s admissions were irrelevant to her right to receive the
proper value of her shares under the shareholders’ agreement, which was an independent agreement
that was not vitiated by her fraud.
The court referenced the “faithless servant doctrine” as a ground to deny Mosionzhnik any
compensation under her employment agreement.[4] Arguably, the court could have used the doctrine
to hold that Mosionzhnik also forfeited her rights under the shareholders’ agreement, as another
Supreme Court justice, sitting in Suffolk County, did in a virtually contemporaneous decision involving a
similar situation, Trimarco v. Data Treasury Corp., Index # 30324/03 (Sup. Ct. Suffolk Co. Oct. 30,
2013.[5]
The Fiduciary Duty Issues. The court divided both sides’ allegation against the other for breach of
fiduciary duty into two categories: “diversion of corporate opportunities and flat-out illegal activity.” The
court ruled that Mosionzhnik was required to disgorge the $500,000 she secretly transferred to the
Swiss bank account as a diversion of corporate opportunities, notwithstanding her reliance on the
provision in the shareholders’ agreement permitting self-dealing and private art transactions.
Because the kickbacks arose from gallery business, not her personal business, and “fiduciaries must
disgorge all wrongful benefits obtained by their disloyalty,” the court granted the gallery summary
judgment but stayed execution pending the conclusion of trial because of Mosionzhnik’s potential setoffs as to the remaining claims.
However, as to the remaining improprieties that Mosionzhnik and Chowaiki each claimed the other
committed, all those bad acts were imputed to the gallery and barred under the doctrine of in pari
delicto, which “mandates that courts will not intercede to resolve a dispute between two wrongdoers ...
Imputation ‘is a legal presumption that governs in every case, except where the corporation is actually
the agent’s intended victim’” — i.e., the adverse interest exception.
However, the exception applies “only where the agent has ‘totally abandoned his principal’s interests ...
it cannot be invoked merely because [the agent] has a conflict of interest or where the agent is not
acting primarily for his principal.’” (citations omitted).
Here, the record unequivocally establishes that the legality of the gallery’s business practices ranged
from the questionable (the champertous funding of European litigation) to the impermissible (using
client property as loan collateral). The gallery cannot recover against [Mosionzhnik] for her bad acts
because the gallery benefited from them .... There is also no question of fact that [Chowaiki] knew of the
questionable nature of [Mosionzhnik's] conduct ... The gallery cannot reap the benefits of
[Mosionzhnik’s] bad acts when times are good and later protest when its relationship with her soured ...
Likewise, questions of fact about whether [Chowaiki's] alleged wrongdoing rose to the level of severity
of [Mosionzhnik’s] actions are irrelevant. [Mosionzhnik] lacks standing to sue … because such a claim is
derivative and belongs to the gallery. However, even if [Mosionzhnik] could maintain such a claim, it,
nonetheless, would be barred by the in pari delicto doctrine for the same reasons that the gallery’s
claims are precluded. (citations and footnotes omitted)[6]
Breach of the Shareholders Agreement. Because the “bad acts” that led to Mosionzhnik’s termination
as an employee were irrelevant to her right to be paid for her shares, the only issue was whether her
shares were worth more than the $500,000 she was required to disgorge from her Swiss account.
The court first pointed out that under the shareholders’ agreement, Mosionzhnik did not have a right to
procure her own accounting report if she disagreed with the gallery’s report. The court then noted that
Mosionzhnik’s accountants, who valued her shares at over $4 million, objected to the gallery’s
accountants’ theory, but did not allege that those accountants made any errors or misstated amounts in
their valuation.
The court found that even though Mosionzhnik did not have a direct equity interest in Zelco, the gallery
funded Project Gamma so that the interest of both Mosionzhnik and Chowaiki in Zelco was equal to
their respective 25 percent equity interest in the gallery.
However, notwithstanding the millions the gallery invested in the project or its appearance on its books
as a multimillion-dollar asset, neither side’s dueling accountants ascribed any independent value to
Project Gamma. Therefore, the court did not attribute any value to Project Gamma in valuing
Mosionzhnik’s shares.[7]
The accountants used different theories, but both were generally accepted accounting principles.
Because the gallery’s accountants followed the valuation protocol set forth in the shareholders’
agreement, the court accepted its $170,000 valuation.[8]
Both sides filed notices of appeal, but then decided to cut their losses and settle. Although not apparent
from the record whether mediation occurred, in a victory for sanity over public acrimony and
mudslinging, they reached a confidential settlement agreement and dismissed the litigation with
prejudice.
The Takeaway
This case teaches lessons both to counsel and businesspeople.
First is the golden rule that honesty and transparency in business dealings is the best policy. The
corollary is the related rule that dishonesty and subterfuge have consequences if you are
caught.
Ideally we should be prescient and anticipate the future and plan accordingly. Unfortunately, we
lack that skill. While as lawyers, we can make reasoned predictions, we can never know what
will actually occur. With hindsight, however, from the record, we know some of the ways in
which the participants erred.
All three principals used one counsel to draft all the operative agreements, including Chowaiki’s
“private” Project Gamma. There may not have been a conflict among the parties at the outset
and the decision to economize on legal fees is understandable. However, this may have been a
poor decision. Separate counsel representing the parties individually would have been subject
to the attorney-client privilege and unlikely to be required to give deposition testimony, as
occurred in this case. Individual counsel may have seen dangers lurking in the documentation
and negotiated different provisions to protect his/her client if relationships went sour.
For example, while the shareholders’ agreement provided a detailed method to value gallery
shares upon transfer under various scenarios, it did not consider the implication of a “faithless
servant” or include a provision for challenging valuation where the shares were to be valued in
the context of a “business divorce” as occurred here. The absence of such provisions in a closely
held business is neither unusual nor necessarily wrong. The agreement, as drafted, provides a
simple and cost-effective mechanism agreed to in advance by all interested parties at a time
when none of them knows whether the provisions ultimately will be to his/her/its advantage or
disadvantage. However, each party gives up prospectively substantial rights to challenge
potentially improper valuations. While there is no automatic “right” or “wrong” answer whether
to adopt such provisions, separate counsel may have helped the parties come to different
decisions.
It is obvious that reputation is extremely important in the international art business. Regardless
of what Mosionzhnik and Chowaiki may have thought about each other at the outset, it
certainly would not have been farfetched to foresee conflict down the road. Rather than expose
their dirty linen to potential clients — indeed the entire international art market — in the event
of discord, we believe that they should have required mandatory confidential arbitration in their
agreements. If, for whatever reason, all the parties agreed that arbitration was not the best
solution when a dispute actually arose, they could have waived arbitration and proceeded to
mediation or court.
Instead, the shareholders’ agreement provided for jurisdiction in the New York federal and state
courts. Court dockets are now published online. The days of going through boxes in storage
facilities in Bayonne, N.J., are long gone. Anyone with a computer can read virtually any
allegation in any pleading, regardless of the ultimate outcome of the dispute. It seems fair to say
that none of the parties to this dispute is better off for the publicity, notwithstanding Oscar
Wilde.
Even though the shareholders’ agreement did not provide for mandatory mediation, we believe
that once the parties realized the potential downside of publicly filed litigation, they certainly
should have given it a try. While mediation, obviously, does not guaranty settlement, it is
confidential and has no downside, other than a relatively modest cost. At minimum, it could
have narrowed the issues between the parties. For instance, each acknowledged that the other
was holding artwork belonging to the other, and countersued for conversion. Although the
parties presumably could have straightened this out on their own without outside intervention,
it was not until four years into the litigation that they exchanged the pieces each acknowledged
the other owned, and withdrew those claims. This portion of their dispute could have been
facilitated by mediation.
Not all relationships are made in heaven, but there seems to be no reason why this one had to
end in the circle of destruction and public hell.
—By Joan M. Secofsky and Richard I. Janvey, Diamond McCarthy LLP
Joan Secofsky is senior counsel and Richard Janvey is a partner in the firm's New York office.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its
clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general
information purposes and is not intended to be and should not be taken as legal advice.
[1] Under the shareholders’ agreement, absent a base valuation per share within the prior two years
pursuant to the procedure set forth (and there was none here), “the purchase price shall be the fair
market value of the shares of stock to be sold determined by the accountants servicing the company
using generally accepted accounting principles, consistently applied.”
[2] Defendants were Chowaiki, the passive investor, a gallery employee, the gallery, Zelco, Chowaiki &
Co. Fine Art, Ltd. and various Jane and John Does.
[3] Mosionzhnik moved for summary judgment on her claims for a declaratory judgment and
conversion. The gallery moved for summary judgment on its breach of contract and breach of fiduciary
duty counterclaims and all defendants moved to dismiss the other causes of action. While the motions
were sub judice, Mosionzhnik withdrew her conversion claim, and the gallery partially withdrew its
conversion claim upon the parties’ exchanges of art belonging to the other.
[4] The “faithless servant doctrine” is a state common law doctrine established in 1886 by the Court of
Appeals in Murray v. Beard, 102 N.Y. 505 (1886), under which employers may refuse to compensate
employees for the time the employees were unfaithful to their duties. Some, but not all, states have
incorporated the doctrine into their common law. In Phansalkar v. Andersen Weinroth & Co., LP, 344
F.3d 184 (2d Cir. 2003), the Second Circuit reversed the district court’s award of $4.4 million on a former
employee’s claim for conversion of shares of stock he received as partial compensation under his
employment agreement. After an extensive analysis of New York’s case law, the court predicted future
developments of New York law. It held that the employee forfeited all compensation after his first
disloyal act, including the value of the shares at issue, not, as the district court held, only compensation
derived from transactions as to which he was disloyal.
[5] The Trimarco decision after a bench trial is contrary. The case involved a consulting agreement
whereby Michael Trirmarco agreed to provide certain services to Data Treasury and an option
agreement granting Trimarco 1.5 million stock options exercisable over a 10-year period (valued in the
range of $10 million to $14 million), regardless of whether he remained employed (and he did not).
Both sides relied on Phansalker. Justice Emily Pines, noting that plaintiff was a Harvard Business School
graduate, found that “his disloyal behavior ... began early in his consultancy ... were both a violation of
the covenant of good faith and fair dealing ... and a breach of his fiduciary duty to that entity as an
employee, chief operating officer, an executive vice president and a member of the board of directors.”
Although the stock option agreement was not dependent on Trimarco’s continuing employment, she
found that it had to be read in conjunction with his consulting agreement. While Trimarco could have
departed from employment without losing his stock option benefits, “infidelity is a bar to a claim for
enforcement ...” Because Trimarco’s disloyalty extended throughout his relationship with Data Treasury,
he was not entitled to exercise any options. (Data Treasury failed to demonstrate that Trimarco’s
disloyalty was a substantial factor causing it damage and she dismissed Data Treasury’s counterclaims).
[6] In addition to being barred by in pari delicto, the court found that many of Mosionzhnik’s claims
were derivative in nature and would belong to the gallery.
[7] Accordingly, the court granted summary judgment and dismissed Mosionzhnik’s claim for a
declaration that she continued to own a 25 percent interest in Project Gamma.
[8] “[I]t is unsurprising (aside from the usual expectation that the experts of adverse parties will
disagree) that [the experts] came to drastically different conclusions about the value of the gallery.
Regardless, the court must accept the [gallery] report because it was prepared in accordance with the
terms of the shareholders’ agreement. If the parties, who constitute all of the involved individuals that
formed the gallery and drafted the shareholders’ agreement, wished to grant a terminated employee a
more substantive right to participate in or challenge the valuation of her shares, they could have drafted
the shareholders' agreement differently. As they did not, they are bound by the express term of the
shareholders’ agreement they all agreed to.”
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